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Furthering debate on economic reforms – A rejoinder

The Pathfinder Foundation (PF) welcomes the well-written and carefully considered critique of its blueprint, ‘Charting the Way Forward: Prosperity for All’, by the Collective for Economic Democratisation that was published in Mirror Business last week.

This critique is an important contribution to the discourse on economic reforms, which needs to take place in this country. In fact, one of the reasons which motivated the PF to produce its blueprint was to generate such discussion and debate. The PF is also very open to critiques that serve to strengthen this document.

In this rejoinder, the PF would like to focus upon two key themes. The defence of the underlying approach, which guided the drafting of this blueprint, and a response to the criticism made in the article by the Collective for Economic Democratisation.

Underlying approach

First the underlying approach. The blueprint has drawn upon several studies commissioned by the PF from authors with different ideological backgrounds. We have strived to adopt a pragmatic problem-solving approach in drafting the document. The authors of the critique have contended that the blueprint is based on the neo-liberal orthodoxy of the 1980s and 90s (the Washington Consensus). It is our hope that this rejoinder will serve to confirm that the blueprint is not constrained by a neo-liberal ideological straight jacket.

In our view, it is also pertinent to pose the question whether the authors’ critique harks back to the failed welfarist policies of the 1960s and 70s, which delivered low investment, high unemployment and high inflation (queues and black market prices) for the people of Sri Lanka.

This welfarist orientation also ignores the constraints imposed by Sri Lanka’s graduation to lower-middle-income country status and the consequent loss of access to highly concessional borrowing. In today’s context, it is far more costly for this country to live beyond its means, in economic, social and political terms. It is the poor and vulnerable who are most exposed to the dangers of a debt/economic crisis, as we have seen in Greece and other European countries. The effects would be even direr in a poorer country like Sri Lanka.

Austerity discredited?

We would now like to address some of the specific criticisms of the blueprint. A major thrust of the Collective for Economic Democracy article is that the PF is advocating austerity, which has been discredited. It also goes on to contend that the policies advocated by the PF would have severely adverse consequences for the poor and increase inequality. Each of these claims needs to be examined in the context of what is actually in the blueprint.

On austerity being discredited, one needs to pose the question why countries have had to embark upon such policies the first place, particularly in Europe where the debate has been most intense. Governments of various political persuasions, conservatives, social democrats and coalitions have all adopted these policies. The on-going debate is not whether countries living beyond their means and are uncompetitive should take tough remedial action. Instead, it is about how the pain of austerity is distributed among the rich and poor, old and young, etc. It is also about whether it has gone too far.

It is also noteworthy that Iceland, Ireland, Portugal and Spain are now recovering after implementing austerity policies. Greece is a special case because the original problem was far more severe. One may argue that it should have been recognized that the Greeks were insolvent, and less severe austerity should have been imposed upon them, supported by debt write-offs and more financing. However, the German tax-payer has been unwilling to bankroll this. So the main point here is that one cannot conclude that remedial measures are not necessary in a country living beyond its means. These measures will inevitably be painful. In the following paragraphs, the case will be made that Sri Lanka has been living beyond its means.

This brings us to the criticisms regarding the need for fiscal consolidation (austerity measures) and the concerns about the distribution of the pains resulting from such policies. The critique of the blueprint is that it is oblivious to the interests of the poor and vulnerable, as well as an increase in inequality. We will address each of these in turn.

Need for fiscal consolidation (austerity measures)

First, the need for fiscal consolidation (reducing the budget deficit and containing government borrowing) -- This is usually at the heart of austerity packages. The Collective for Economic Democratisation has emphasised that the PF is committed to reducing the role of the state on the basis of ideology. One would have no quarrel with the welfarist position expounded in the critique, if it can be demonstrated that Sri Lanka can adopt such policies without creating a large budget deficit which fuels inflation, which is a highly regressive implicit tax on the poor, as well as a severe debt crisis.

Already the debt/gross domestic product (GDP) ratio is 75 percent (even without contingency liabilities) compared to 39 percent for our peers. Debt-servicing absorbs over 90 percent of government revenue. There has been a very rapid build-up of external debt, with the debt service ratio rising above 20 percent (the rule of thumb threshold for amber light territory). Our net reserve position is narrow in relation to our import requirements. In addition, the current account of the budget has been in deficit in every year since 1976.

This means we have been borrowing to finance some of our recurrent expenditure for the last 39 years. (Borrowing for capital expenditure is justifiable provided the economic returns are acceptable.) The budgetary position has become even more fragile after the budget speech (November 2014) and especially the interim budget (January 2015). This is the landscape against which the PF has made a strong plea for fiscal consolidation (austerity in the language of the critique). This call is based on a pragmatic assessment of the macroeconomic prospects of the country, not neo-liberal ideology.

Another point to be made is that the critique of the Collective for Economic Democracy does not pay adequate attention to affordability. It is affordability rather than a blind faith in austerity which has motivated the PF approach to fiscal sustainability.

Taking account of distributional issues

It is also important to point out that the recommendations contained in the blueprint are sensitive to the distributional aspects of the cost of adjustment i.e. the pain. The PF has not advocated a ‘slash and burn’ approach to fiscal consolidation which ignores the impact on the poor and vulnerable. On the revenue side, it has called for greater reliance on direct taxes which are less regressive than indirect ones. The government is currently dependent on the latter for about 80 percent of its revenue.

The blueprint has also recommended the improvement in the efficiency of welfare payment delivery through the use of biometric cards, mobile phones and bank accounts. There is also a call for a rigorous public expenditure review based on carefully worked out priorities. Distributional considerations can be built into such an exercise. For instance, the critique correctly cites recent International Monetary Fund (IMF) findings that every dollar/rupee spent on the poor generates far higher growth than on the rich. This can inform the setting of priorities which drive the proposed public expenditure review.

Increased inequality?

These recommendations also serve to address the criticism that the measures advocated by the PF would increase inequality. In addition, a key message in the blueprint is the importance of empowering people through education, training and skills development to participate in a modernizing economy. This is a more sustainable means of addressing inequality than welfarist policies which have become even more unaffordable with the loss of access to concessional financing.

The PF would also like to stress that nowhere in the blueprint has it advocated an attack on the universal provision of health and education. Instead, we have pointed out that the current complicated system of subsidies, administered prices and income transfers is inefficient and unsustainable. There is a recommendation for a well-designed and targeted income transfer programme, supported by technology, to meet the needs of the poor and vulnerable. Recent World Bank research has found that the current system of subsidies and transfers benefits the better-off disproportionately. The Collective for Economic Democratisation has mistakenly conflated two very different ideas. The UNDP Human Development Report 2014 advocates universal provision of health and education. It does not support untargeted subsidies and transfers.

Role of state

The Collective for Economic Democratisation also contends that the PF has taken a dogmatic position on the role of the state. The authors cite the role of the state in East and Southeast Asia in their article. In these countries, the state had the capacity to play a larger role as they had autocratic systems (at the time of transformation) which were able to minimise welfarist measures and release resources for state-led development programmes. The article claims that the PF is being anti-democratic by advocating an overly technocratic approach. By citing the E and SE Asian experience of the role of the state, the article seems to be falling into an even more anti-people/democratisation trap, given the current situation in Sri Lanka compared to the autocratic conditions which prevailed in those countries at the time of their transformation.

The PF has not argued for a diminished role for government in relation to creating a conducive environment for development, regulation, well designed and targeted redistributive policies, or even industrial policy. The challenge is to find what works for us and is affordable.

Arguably, the most important message in the PF blueprint is that all welfarist measures should be costed and the financing identified.

Holistic reforms

Also, PF has recognised that stabilisation measures (austerity) alone are not sufficient. They need to be supported by structural reforms and human resource development. In addition, there has not been a dogmatic approach to things like privatisation and downsizing the public service. A carefully calibrated and sequenced strategy has been advocated.

On the structural policies, the PF supports a private sector-driven approach to development. Here again, it is pragmatism which leads us to this conclusion. Sri Lanka’s fiscal deficit and public debt profile greatly circumscribe the role which the state can directly play in boosting economic activity. In addition, the reality of high levels of politicisation makes it very difficult to run commercially efficient state-owned enterprises (SOEs).

Win-win labour laws

The Collective for Economic Democratisation claims PF has advocated anti-labour measures. It points out that corporates are circumventing even existing labour laws through casualization of formal sector employment. The PF has argued that the current outdated and inflexible labour laws which are incentivising companies to resort to temporary and casual employment. These laws and their attendant costs are also discouraging small enterprises from graduating from the informal to the formal sector. The resulting perverse outcome is lower overall labour standards.

PF is not advocating a ‘hire and fire policy’. Instead, it is calling for a pragmatic and modern approach to labour laws involving business, trade unions and government. Such a constructive approach has enabled Germany to become the most successful exporting country in the world, while maintaining very high labour and environmental standards. Similarly, in Sri Lanka, we should seek a pragmatic approach to labour laws which assist in generating higher value employment and better overall labour standards.

Is there a contradiction?

The article also claims that there is a fundamental contradiction in PF advocating capital, debt and pension market development while pointing out that Sri Lanka is becoming increasingly exposed to rating agencies and international capital markets. This is similar to saying that one should not get into a motor vehicle because there could be an accident. Markets will punish mismanagement in the same way that bad driving can lead to accidents. Nobody would argue that all the convenience of motorised travel should be avoided because of the danger of accidents. In the same way, financial and capital markets should be well developed and regulated to garner the benefits while guarding against the dangers. There is no sense in throwing the baby out with bathwater.
The article also mistakenly argues “financialisation” (i.e. financial and capital market development) was the cause of the Asian financial crisis. It was actually triggered by the maturity mismatch of the external borrowing of commercial banks, starting with Thailand (i.e. they undertook cheap short-term borrowing in foreign currency and lent long-term in domestic currency). Nobody would argue that we should not have any commercial banks because of this.

The article has also mistakenly conflated capital and financial market development with liberalisation of the capital account of the balance of payments. It was capital account liberalisation which amplified the Asian financial crisis and fuelled contagion. The blueprint does not advocate capital account liberalisation. This calls into question the criticism made that the PF is blindly wedded to “financialisation”. Capital account liberalisation is not a necessary precondition for developing capital and financial markets. More sophisticated financial intermediation, as well as increased pension and insurance products, can boost growth and provide protection to a wide cross-section of Sri Lankan society.

Pragmatism and problem-solving are our watchwords not dogma or ideology

We would like to conclude that the PF has sought to adopt a pragmatic problem-solving approach in its blueprint. It is, of course, very willing to concede that there is much that can be done to improve it. The Collective for Economic Democratisation has made a major contribution to the debate on economic reform. However, they have had some difficulty in not allowing dogma and preconceived notions to cloud their perspective.